What does this surprise election result mean for the markets

Following the surprise UK General Election result, Schroders considers the implications for the economy and markets.

Economics view: From coronation, to contest, to capitulation

Azad Zangana, Senior European Economist, Schroders, said:

"This is a disastrous result for the Conservative party, which must raise questions over the future of Theresa May as Prime Minister. As the largest party following the election, the Conservatives are likely to remain in power as a minority government, relying on the confidence and supply of votes from friendly opposition members of parliament. This suggests a less stable government, one that will have to make concessions and seek a consensus even when introducing simple changes to legislation.

What it means for the economy

"For the economy, households and corporates will be concerned by the increased political uncertainty. However, at the same time, the paralysis in Westminster will mean fewer changes to fiscal and economic policy. Despite this, we expect a pull back in household spending and business investment which will exacerbate the slowdown currently being experienced.

The effect on the pound and BoE policy

"The fall in the pound has been smaller than expected given the hung parliament. At the margin, lower sterling will push up inflation a little further than previously forecast, which will have a small negative effect on household spending.

"The Bank of England is unlikely to change its policy in the near-term but it will offer reassurance that it stands ready to act in the event of financial instability.

"Looking ahead, there is a high chance that any Conservative minority government may not last beyond a year. It will likely struggle to pass any finance bill.

What about Brexit?

"As for Brexit, serious damage has been done to the UK's negotiating position. Without a strong mandate, Europe can ignore the UK's demands. Even the UK's threat to pull out of negotiations will now appear hollow and lacking the support of the British public."

Equities view: Firms with international earnings may benefit from sterling weakness

David Docherty, Fund Manager, UK Equities, Schroders, said:

"Even if the Conservatives are able to form a government, this result significantly reduces Theresa May's authority and her ability to negotiate Brexit.

"An initial flight to safety is likely in UK equities as investors favour resilient companies with international earnings.

"Economically-sensitive domestic consumer companies, such as general retailers, may be vulnerable to a weakening pound. This is because foreign exchange moves impact their profit margins and the real disposable income of their customers. Other domestic financial stocks such as banks, housing and real estate may also be weak.

Brexit, taxation and renationalisation?

"Longer term, a recovery in sterling is possible were the market to discern a reduced likelihood of Brexit actually taking place. A stronger growth narrative might also emerge as the opposition parties argue for greater public spending.

"In the meantime, given Labour's greater proximity to power, investors will start to calibrate the impact on companies of the higher taxation and significantly greater government intervention (including nationalisation) inherent in the Labour manifesto.

"As much as these political events drive fierce debate, investors will also place them in the context of other factors. These include the general global economic backdrop, the valuation of UK equities and bottom-up stock selection considerations."

Fixed income view: Inflation is expected to rise

Alix Stewart, Fund Manager, Fixed Income, Schroders, commented:

"One of the risks from today's election result is that prices are likely to rise more than people had been previously expecting. This will likely be due to a combination of increased government spending and a weaker pound.

The outlook for bonds

"The outlook for UK government bonds is more uncertain. However, they are likely to sell off at least initially as investors will require a higher return from them. This is because more government spending means more borrowing through bond markets and the higher inflationary environment.

"Longer term, however, UK government bonds should remain well supported due to the economic uncertainty caused by the political turmoil in the face of looming Brexit negotiations."